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Financial Assets
Classification and subsequent measurement

Financial AssetsClassification and subsequent measurement

Subsequent measurement

Two types of FA are FVOCI• Investments in equity irrevocably designated FVOCI. If this option is chosen only dividend income that does not clearly represent a recovery of part of investments is recognized PL with all other gains or losses in OCI. These remain in equity and are not subsequently transferred to PL even on derecognition. However the entity may transfer the cumulative gain or loss within entity• Debt instruments at FVOCI. For these changes in FV should be recognized in OCI except for:o Interest calculated using EIRo Forex gains and losseso Impairment gains and lossesUntil the FA is derecognized or reclassified.When the FA is derecog the cumulative gain or loss previously in OCI is reclassified from equity to PL as relcas adj under IAS 1.If a debt instrument asset is measured FVOCI the amounts that are recognized in PL are the same as the amounts that would have been recognized in PL if FA had been measured at Amor Cost

Assets classified at FVPL are measured at FV. Gains and losses that arise as a result of change in FV are recognised in PL, except for those arising on hedging instruments that are designated in effective CF hedges or hedges of net investments in foreign operations.Gains/losses that arise between end of last reporting period and date an instrument is derecognised do not constitute a separate 'PL on disposal. Such losses will have arisen prior to disposal, while the item is still being FVPL and should be recognised in PL when they occure

Amortised cost requires application of EIR. It is defined as the amount at which the FA or FL is measured at initial recognition minus principal repayments, plus/minus cumulative amortisation using EIR of any difference between initial amount and maturity amount, adjusted for any loss allowance.Gains and losses from fluctuations if FV are not recognised for FA classified in amortised cost category

Unquoted equity instrumentsIAS 109 requires all equity to be FVPL. However in certain limited circumstances cost may be an appropriate estimate of FV (e.g. insufficient info, wide range of FV measurements). Cost is never the best estimate of FV for investments in Quoted equityThe list is not exhaustive. All info about performance and operations of investee should be used. To the extent that any relevant factors indicate that cost may not be appropriate FV, entity is reqd to calc FV.

IAS 109 has spec reqs for FAs that are hedged items

Business model assessment

BM to hold assets to collect contractual CF• In this case the entity manages the assets held within the portfolio to collect those particular contractual CF.• To consider frequency, value and timing of sales in prior periods, the reasons for those sales and expectations about future sales activity. However sales in isolation do not determine BM. Instead info about past sales within context of reasons for them and existing conditions as well as expectations about future sales provide evidence as to how entity’s stated objectives for managing FAs and specifically how CFs are realized.• Even if BM is to hold FAs for CF, the entity need not hold all of those i.e. BM can be CF collection even if sales of FAs are expected in future. (sales because of rise in credit risk and other reasons such as managing credit concentration risk)• If there are more than infrequent number and more than insignificant value of such sales (either individually or in aggregate) the entity needs to assess whether and how such sales are consistent with BM. Whether a third party imposes the requirement to sell FAs is irrelevant. An increase in frequency or value in a particular period is not necessarily inconsistent with BM. Further sales made close to maturity where proceeds include all remaining CFs may be consistent with BM

BM to both hold to collect CF and sell:• Various objectives consistent with this BM e.g. objective to manage everyday liquidity needs or to maintain a particular interest yield profile or match duration of FA to duration of FL. To achieve such objective entity will both hold and sell.• Compared to other BM this will have higher frequency and value of sales because selling is integral, not incidental, to achieving objective. However there is no threshold here

Contractual CF characteristics test

• For a FA that is a debt instrument to be measured at Amortized cost or FVOCI, its contractual terms must give rise on specified dates to CF that are SPPI. For purposes of SPPI, principal is FV of FA at initial recognition (however this may change over life of FA e.g. if there are repayments of loan) AND interest is consideration for TVM, credit risk associated with principal amount and for other lending risks, admin costs and profit margin.• The assessment is done in currency in which FA is denominated. In practice only debt instruments meet such criteria. Derivative assets and equity instruments wont.• Contractual CF that are SPPI are consistent with a Basic Lending Agreement. It consists of things mentioned in point 1. But contractual terms that introduce exposure to risk or volatility that is unrelated to a BLA such as exposure to changes in equity prices or commodity prices etc. don’t give rise to CF that meet SPPI.• An originated or a purchased FA can be a BLA irrespective of whether it is a loan in its legal form

Consideration for TVMIn order to assess whether element provides consideration only for TVM an entity applies judgement and considers factors such as currency and period for which interest is set

Floating rate loansA FA that has a variable rate of interest that consists of TVM, risks associated with principal, and other Basic lending risks and costs as well as profit margin will meet contractual CF testHowever if rate moves in a direction opposite to interest Rate Index it will not meet the test

Prepayment option• A contract may permit issuer to repay, holder to put back a debt instrument before maturity. Whether a RO passes contractual CF test will depend upon what events are needed to occur that then permit the repayment and how much is repayment amount. Generally both factors are important.• When amount or timing of CF is contingent upon a future event, consideration must be given to nature of event. It is not determinative but indicative.• Hence a RO that is exercisable only when an event happens that is unrelated to risks associated with BLA, TVM, credit risk of borrower, liquidity risk etc. The inclusion of risks unrelated to a BLA may not provide return of principal and interest on principal.

Extension optionA contract may permit extension of term of borrowing. Whether an extension passes CF test will depend upon the events that are needed to occur for extension as well terms of instrument following extension and for remaining life.

Perpetual debt instrument• The fact that it is perpetual does not mean it fails the test. Consideration given to contractual interest rate and also to whether it includes consideration for TVM, risks etc. Variability in CF other than this will generally result in failing of test• It is like a stream of continuous extension options. Such options will result in CF that are payments of principal and interest if contractual CF following each interest payment (i.e. extension option) are themselves considered SPPI.• Perpetual interest may also be prepayable. It shall be treated same as prepayment on redeemable debt.

LeverageIt is a CF characteristic of some FA. it increases variability of CF with the result that they do not meet the CF test. Such instrument will be classified as FVPL.Leverage is regarded as a multiple greater than one. Hence if CF was LIBOR into 1.1 then it would be leveraged.

Amortized cost

Conditions for measuring FA at Amortized cost• BM test – To hold FAs to collect CF• Contractual CFs are SPPI, where interest is compensation for TVM

FVPL

Any instrument not qualifying for Amortized cost or FVOCI as well as FA that are HFT or designated at initial recognition as at FVPL must be measured subsequent to initial recognition at FVPL

An entity may at initial recognition designate a FA as FVPL if that designation eliminates or significantly reduces a measurement or recognition inconsistency (‘accounting mismatch’) that would have occurred if FA was FVOCI or amortized costInvestments in equity are required to be FVPL, except certain investments in equity meeting specific criteria may be irrevocably designated as FVOCI

A FA is HFT if:• It is acquired principally for the purpose of selling it in near term• On initial recognition it is a part of a portfolio of identified FIs that are managed together and for which there is evidence of a recent actual pattern of short-term profit-taking• It is a derivative (except for derivative that is a financial guarantee contract or designated and effective hedging instrument)

FVOCI

Conditions for measuring FA at FVOCI• BM test – To hold FAs to collect CF and for sale• Contractual CFs are SPPI, where interest is compensation for TVM

At initial recognition an entity may make an irrevocable decision to present equity instrument that is not HFT nor contingent consideration recognized by an acquirer in a Business Combination to which IAS 103 applies. This decision is made on instrument to instrument basis